Debt consolidation

Debt consolidation entails taking out one loan to pay off many others. This is often done to secure a lower interest rate, secure a fixed interest rate or for the convenience of servicing only one loan.

In other words we can say that it is the process of combining many debts into a single payment, usually resulting in lower monthly payments. There is also then only one creditor to pay.

Debt consolidation can simply be from a number of unsecured loans into another unsecured loan, but more often it involves a secured loan against an asset that serves as collateral, most commonly a house. In this case, a mortgage is secured against the house. The collateralization of the loan allows a lower interest rate than without it, because by collateralizing, the asset owner agrees to allow the forced sale (foreclosure) of the asset to pay back the loan. The risk to the lender is reduced so the interest rate offered is lower.

Sometimes, debt consolidation companies can discount the amount of the loan. When the debtor is in danger of bankruptcy, the debt consolidator will buy the loan at a discount. A prudent debtor can shop around for consolidators who will pass along some of the savings. Consolidation can affect the ability of the debtor to discharge debts in bankruptcy, so the decision to consolidate must be weighed carefully.

Debt consolidation is often advisable in theory when someone is paying credit card debt. Credit cards can carry a much larger interest rate than even an unsecured loan from a bank. Debtors with property such as a home or car may get a lower rate through a secured loan using their property as collateral. Then the total interest and the total cash flow paid towards the debt is lower allowing the debt to be paid off sooner, incurring less interest. In practice, many people are in credit card debt because they spend more than their income. If that habit continues, the consolidation will not benefit them much because they will simply increase their credit card balances again.

Because of the theoretical advantage that debt consolidation offers a consumer that has high interest debt balances, companies can take advantage of that benefit of refinancing to charge very high fees in the debt consolidation loan. Sometimes these fees are near the state maximum for mortgage fees. In addition, some unscrupulous companies will knowingly wait until a client has backed themselves into a corner and must refinance in order to consolidate and pay off bills that they are behind on the payments. If the client does not refinance they may lose their house, so they are willing to pay any allowable fee to complete the debt consolidation. In some cases the situation is that the client does not have enough time to shop for another lender with lower fees and may not even be fully aware of them. This practice is known as predatory lending. Certainly many, if not most, debt consolidation transactions do not involve predatory lending.

After selecting a debt consolidation firm, the firm will get the required debt and finance information from you. The firm then calls your creditors and negotiates on your behalf. These lower rates are pre-set by creditors. Usually, the firm can negotiate lower monthly payments, lower interest rates, and reduce or eliminate late fees. This allows you to pay one, lower bill and pay off your debts in lesser time. In return for this service, you must agree to pay, on time, the agreed upon lower payment while meeting other living expenses. You must also agree to stop increasing your debt or using credit cards. When creditors know that you are working with debt consolidation, they quit harassing you. If they do call, a good firm will usually call them for you and explain the situation.

It often involves many credit card bills into a single payment but with collateral backing it up. This is then referred to a secured loan. This is not always necessary so do contact a company to look over your individual case. By doing so, a lower interest rate is often available since there is something of value backing it up. If in the case of you not being able to pay back what you owe, then the collateral can be seized in order to pay the amount you owe. All of this can be confusing so it is best to contact a quality company and explain your situation. They will talk to you free of charge with no obligation and provide options as to what they can do for you. From there you can determine what is best suited for you.

In recent years, reports in the media have raised concerns about the use of consolidation loans. The worry is that many people are tempted to consolidate unsecured debt into secured debt, usually secured against their home. Although the monthly payments can often be lower, the total amount repaid is often significantly higher due to the long period of the loan. Debt consolidation sometimes only treats the symptoms of debt and does not address the root problem. In some circumstances, snowballing debt may be a better solution.

There are other alternatives to a debt consolidation loan, where unsecured debt is not "shifted" to secured debt, but is eliminated through a settlement or payment plan.

Warning: Debt consolidation can be confusing for many people, so it is helpful to learn about all of your options, and sometimes with the help of an advisor.